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One thing that may have been missed in the Federal Emergency Management Agency’s recent release of Risk Rating 2.0 — its first major update to the National Flood Insurance Program’s pricing system in 50 years — is that the new pricing system applies to businesses as well as homeowners. Commercial properties account for 4%, or 199,394, of total NFIP policies, according to market sources. To put that in context, the NFIP provides around $1.3 trillion of flood insurance coverage for more than 5 million policyholders across the United States. The new pricing system will apply to all properties insured through the NFIP and all categories of policies will see increases or decreases.
Risk Rating 2.0 sets out to provide actuarially sound flood insurance rates that should be more equitable and easier for policyholders to understand, leveraging improved technology and understanding of flood risk. For policyholders, the change means that premiums will be based on a property’s value and specific flood risks, such as proximity to the coast and the risk of flooding, rather than just its elevation in a flood zone. For some parts of the U.S. that are prone to coastal storms, surges and floods like Florida, where property rate hikes are already significant, this will mean even higher costs for insurance buyers.
In developing the new rates, FEMA coordinated with subject matter experts from the U.S. Army Corps of Engineers, U.S. Geological Survey and the National Oceanic and Atmospheric Administration, as well as experts from the insurance industry and actuarial science. David Maurstad, senior executive of the NFIP, described the new pricing system as “the right thing to do. It mitigates risk, delivers equitable rates and advances the agency’s goal to reduce suffering after flooding disasters.” FEMA’s long-overdue recalibration comes after the NFIP racked up $20 billion in debt when claims resulting from multiyear hurricanes exceeded premiums.
What does all that mean? Out of the 199,394 NFIP commercial policies, some 43% are expected to see premium decreases. But for many of the tens of thousands of businesses with NFIP coverage, there will be material increases. Some 27%, or 53,836, of commercial NFIP policies, will see their premiums increase by more than $240 a year, sources say. Any premium increases will transition gradually and within the existing statutory limits until the full-risk rate for the property is reached.
Despite the premium increases, there are reasons for optimism from a risk and risk management standpoint. The new pricing system will likely act as a stronger disincentive to locate businesses in areas prone to flooding, and businesses will have increased incentives to mitigate against flood risk.
Since Risk Rating 2.0 is actuarially on a sounder footing than its predecessor, it’s also likely the higher rates will push more businesses into the private flood market, which could lead to increased competition.
For private flood insurers and alternative capital risk vehicles, the Risk Rating 2.0 system presents an opportunity as businesses, already balancing tough commercial insurance market conditions, will be eager to smooth the volatility of rising flood coverage costs and losses by shopping around and looking for alternatives. Putting public coverage on a more commercial footing should help the private market rise to the challenge of solving a problem that is only likely to get worse.